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Foreign Bank Prudential Standards Could Impact Operations, Capital

As foreign banking organizations (FBOs) gain familiarity with the Federal Reserve Board’s final enhanced prudential standards, they are likely to conclude that the rules usher in a new era of supervision and enforcement. These regulations are a significant landmark in the Federal Reserve’s oversight of foreign banks’ operations in the United States. “While the Federal Reserve’s past statements have pointed the way to a more vigorous role in regulating FBOs through its supervisory process, these more prescriptive rules finally make it official,” says Deborah Bailey, vice chairman, Deloitte & Touche LLP’s Governance, Regulatory & Risk Strategies practice.

Deborah Bailey

The final rules’ most significant mandate concerns the formation of a legal entity structure for FBOs with the largest U.S. operations and imposes U.S. capital and liquidity requirements on those operations. Using the intermediate holding company (IHC) structure, these FBOs are expected to comply with many of the same regulations that large U.S. banking organizations must follow or are expected to follow.

“To achieve these goals, many organizations may need to inject significant additional captive capital and funding into U.S. operations that are complemented by investment in U.S. infrastructure—including systems, data, governance, risk management and reporting,” adds Ms. Bailey.

The Scope and Near-term Considerations

The final rule for enhanced prudential standards for FBOs generally applies to institutions with total global consolidated assets of $50 billion or more, and certain provisions apply to entities with total global consolidated assets of $10 billion or more. FBOs that meet the $50 billion asset threshold and that also have $50 billion or more in U.S. non-branch assets are required to form a U.S. IHC. This threshold for IHC formation represents a significant change from the proposed rules, which included a much lower $10 billon threshold for U.S. non-branch assets.

The final rules will affect several key areas of foreign bank operations, including the following:

IHC/Governance. Size continues to be a determining factor when considering the IHC and other requirements. FBOs with consolidated assets of more than $50 billion globally and U.S. non-branch/agency assets greater than $50 billion will be consolidated under an IHC. This definition of non-branch/agency assets is a clarification in the final rules. These FBOs must have placed at least 90% of their assets under the control of the IHC by July 1, 2016, with the remaining ownership interest in any subsidiaries to be transferred by July 1, 2017. Establishing an IHC may result in a more consistent approach to risk and compliance management, governance and supervision that cuts across business divisions. The IHC structure may also make the IHC financial, capital and liquidity/funding picture more comparable to those at domestic banks with more than $50 billion in assets.

Risk management requirements. FBOs with publicly traded stocks and total global consolidated assets of at least $10 billion, but less than $50 billion, must certify annually to the Federal Reserve that they maintain a committee of their global board of directors that oversees risk related to the U.S. operations. There will also likely be a need to reconfigure management information systems to enable the U.S. risk committee and U.S. chief risk officer to meet new risk reporting requirements that focus specifically on U.S. operations, including activities within the IHC, as well as branches. This may prove to be a significant change for many FBOs.

Capital requirements. With some exceptions, IHCs will be subject to the same capital rules as U.S. bank holding companies. These rules include risk-based capital requirements as defined under U.S. Basel III final rules (except for the advanced approach for credit and operational risk), leverage limits and the market risk rule (if trading requirements are met). These capital requirements are mandatory as of July 2016—while the leverage ratio conformance period is extended until January 2018. There is a continued trend of higher regulatory demands on the amount and quality of capital through regulation, and many large FBOs have already increased their capital levels in anticipation of these rules. No matter where each institution stands, greater awareness is indispensable—because the definition of institutions that fall under the purview of U.S. capital rules is broadening.

Liquidity requirements. The final rules retain many of the same liquidity requirements that were included in the proposed standards, with some key changes and adjustments, such as the 14-day liquidity buffer for FBO U.S. branches and agencies, rather than the 30 days specified in the proposed rule. In addition, U.S. branches and agencies no longer need to report the results of the 14-day liquidity stress test.

Stress testing requirements. For an FBO with an IHC, the results of the home-country stress testing will require reporting to the Federal Reserve. IHCs will be subject to stress testing, consistent with those applied to U.S. bank holding companies (BHCs) of a similar size. The compliance date has been extended to July 1, 2016. Branch and agency operations continue to have a look-through to the home-country stress testing process with the potential for asset maintenance requirements.FBOs will need to assess the data, the modeling and governance implications of the new rules regarding stress testing, as well as the capital requirements, to determine that local requirements can be met.

Early remediation requirements. The Federal Reserve has delayed issuing final rules for early remediation, likely due to unfolding developments regarding single point of entry, global loss absorption capacity, and for FBOs the development of international recovery approaches.The decision to delay this section and await more guidance from the Basel Committee appears to offer further evidence of U.S. banking regulators attempting to work more closely with the global bank regulatory community.

Counterparty requirements and implications. The final rule doesn’t specifically address single-counterparty credit limits and will likely be re-scoped and aligned to international efforts. The Federal Reserve may determine that more analysis is required and will likely consider the results of two quantitative impact studies expected to be released later this year. Those studies will evaluate whether, and to what extent, specific proposed counterparty limits might affect credit availability.

Regulatory reporting requirements. The Federal Reserve already has an infrastructure for analyzing banking organizations from a financial and risk perspective, and the same approach was proposed to apply to IHCs. However, it is widely anticipated that reporting requirements will remain unchanged from the proposed rules—with the exception of the FFIEC 101 because the “advanced models” approach for capital is no longer mandatory for the largest foreign banks. “We expect these regulatory reporting requirements to exact a heavy toll. Once FBOs have developed an understanding of the reports, they may require more resources, an enhanced data collection and reporting infrastructure, and new processes for careful and timely preparation,” says Ms. Bailey. “They may also need realignment of existing reporting to provide the information for U.S. reporting, as well as meeting parent company needs.”

The data imperative. FBOs operating in the U.S. are expected to meet similar reporting standards as U.S. BHCs. The requirements for liquidity, capital and stress testing presume a view of risk and finance data at granular levels that are transparent across U.S. operations. This requirement alone presents challenges for the largest FBOs, as many of these firms currently operate as separate business units and have disparate data processes, architectures and infrastructures to support a centralized risk management and reporting environment. “The bar for good data is incredibly high in the enhanced prudential standards—and the learning curve is steep, even before accounting for the need to establish U.S.-centric processes,” notes Ms. Bailey.

Finish Line

For the largest FBOs, the requirement to create an IHC is designed to help the Federal Reserve provide more consistent supervision across a range of areas like capital, liquidity, risk and stress testing. At the same time, some FBO activities will likely be constrained. Even FBOs that do not meet the thresholds for IHC formation may have to make significant changes to their governance models and infrastructures to comply with additional risk and liquidity requirements. “As we said in analyzing the proposed rules last year, it’s a daunting to-do list. But it helps to have the finish line established once and for all,” says Ms. Bailey.

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